You’re ready to invest. Financial goals are in hand. Time horizons are nailed down. You know how much risk you want to take. Now what? There’s so many investments to choose from! Building a lower risk ‘core’ with some riskier ‘satellites’ is a great investing strategy to get you to you goals.
What is a portfolio investing strategy?
A portfolio investing strategy is simply the strategic mix of investments that you put in your portfolio. Using one adds structure. It ensures a broad, diversified mix that reduces your risk and gets you to your longer term goals. Without one it all ends up a bit of mess, usually with too many investments in one part of the market, and too few in others.
What is a core and satellite approach?
The core / satellite approach is one way of constructing your portfolio. It frames your investments, points them in the right direction of your goals and reduces your overall costs. It also enables you to have some fun investing in the Uk, one of the oldest and most dynamic investment markets in the world. What is more, core / satellite isn’t just a strategy for beginners – anyone with a portfolio can retroactively apply this model.
Where did it come from?
Of course, the strategy was born out of the US – the stock market motherland. It is based the idea of blending a larger ‘core’ of low cost, less volatile, passive investments, such as trackers and Exchange Traded Funds (ETFs), with smaller ‘satellite’ positions in racier, actively managed products such as funds and investment trusts.
It’s meant to deliver the best of both worlds: diversified, plain-old boring market equivalent returns from passive investments, aimed at hoisting you to your goals, blended with the potential for market beating returns from more interesting but riskier active funds to give you a little extra juice.
In truth, the strategy has morphed somewhat over time. This is because many retail investors don’t want an entire core dedicated to funds sans a fund manager. Here, we discuss the wider interpretation of the strategy and offer some example investments that may fit the mould.
What’s in the ‘core’?
Think of the core as the Zen palace at the centre of your portfolio. This centre is where majority resides, likely around 65% – 90%, but typically 80%. It is the strategic, long-term, less risky part of the portfolio that does the heavy lifting towards your goals. In itself, this part of the investing strategy should be enough to get you there.
Depending on your attitudes to risk and timeframes for investing, think of a mix of lower risk shares and bonds that works for your goals and use this structure in the core. It should underpin your portfolio with strength and ballast, and make it less volatile when the proverbial mess hits the fan and markets grind downwards during crises.
Types of assets:
- Less volatile mainstream assets (e.g. larger company shares or bonds).
- Developed market investments (e.g. UK or US).
- Low cost multi-asset / multi-manager portfolios
- Also, illiquid investments that may need holding for long periods of time i.e. physical property, Defined Benefit (DB) pensions, Venture Capital Trusts (VCTs), and cash.
Keeping costs down doesn’t necessarily mean investing in trackers or ETFs: plenty of actively managed portfolios offer very low management fees for investing in mainstream assets. A good example is The City of London Investment Trust. With a fund manager selecting investments, it invests in the large UK companies of the FTSE-100, and charges just 0.36%. While this is slightly more than a tracker, it is still a very low fee for active management. Plus, you get the advantage of the investment trust structure with extra features such as gearing (see video).
Fund ideas for your ‘core’
Adrian Lowcock – Head of Personal Investing, Willis Owen
This fund invests across the world, excluding the UK, and is cheap. The fund benefits from one of the most well-resourced passive investors who focus on portfolio optimisation to ensure performance is in line with the benchmark.
Darius McDermott – Managing Director, Chelsea Financial Services
Managed by David Coombs, this multi-asset offering invests in actively-managed funds and investment trusts, as well as passives and direct equity holdings.
The fund manager uses a disciplined asset-allocation framework and a forward-looking assessment of how the performance of assets correlate, plus risk and return, as the cornerstone of the investment process. Asset classes are divided into three distinct categories – liquidity (those that can be bought and sold easily), equity risk (shares in companies) and diversifiers (which includes the likes of options and gold).
This rock-solid performer has a target of the Consumer Price Index (CPI) measure of inflation plus 3-5 per cent per annum, over a minimum five-year period. It also has an ongoing charge of 0.62 per cent, which is attractive.
What’s in the ‘satellite’?
The satellite bit of the investing strategy is where the fun is at. These are the racier, risker investments.
Satellites present an opportunity to dial up some risk and try and bat for bigger returns, comforted by knowing that only a small portion will ever be invested in these positions and therefore only smaller relative amounts could be lost in the event of catastrophe.
The extent of your portfolio in satellites is again down to personal preference, and can be anywhere from 10 – 35%, but typically 20%.
Another advantage of this approach is that, while you are concentrating certain risks in order to try and gain a bigger return – for example using niche assets like renewable infrastructure or more concentrated funds – you are also likely diversifying across a more varied set of investments and into parts of the market whose performance is less likely to be correlated to mainstream assets. This balances the portfolio and may offer some protection against broader market shocks.
Finally, satellites can be used to take advantage of shorter-term opportunities as and when they arise. It means some investors like ETFs in their satellite positions as they can be traded very quickly and easily and used to take advantage of shorter-term market moves.
Types of assets:
- Same assets as core, but more aggressive exposure i.e. more highly concentrated portfolios or those more differentiated from their benchmark (known as higher active share).
- Niche assets (i.e. infrastructure or property though Real Estate Investment Trusts (REITs),
- Emerging markets, frontier markets, or niche markets (e.g. China or India)
- Investment themes (e.g. value vs growth, or technology).
- Smaller companies shares.
- Individual shares.
- Fledgling financial products such as Peer to Peer (P2P) lending or crowdfunding, or cryptocurrencies.
Ideas for ‘satellites’
Adrian Lowcock – Head of Personal Investing, Willis Owen
This fund is complementary to the L&G index fund as it invests in the UK. The focus on smaller companies means it is a riskier investment. The team led by Dan Nichols focuses on companies able to grow their earnings faster than the market average.
Darius McDermott – Managing Director, Chelsea Financial Services
Goldman Sachs Indian Equity Portfolio
A young and growing workforce, rapid urbanisation, economic reform, and a move towards digital and technological growth are just some of the trends that have made Chelsea big supporters of Indian equities over the long-term.
This is an all-weather India fund with a well-resourced and experienced team, based on the ground in India and Singapore. It has a solid investment process and we particularly like the many company meetings the team undertake.
The 70-90 stock portfolio has a bias towards medium and smaller companies, so it is heavily dependent on the Indian economy.
What are the risk with a core / satellite investing strategy?
While the core / satellite strategy provides a good structure to diversify the risks you’re taking, it doesn’t eliminate them – far from it, as you need risk to gain a return. All assets (pretty much) go down during significant market wobbles. So, no matter how you approach stock market investing – you must remember to hold on tight during these crises and ride it out.
*Please note, none of the investment ideas are recommendations. These are simply example ideas that match with core & satellite investing strategy.